Oil is the world’s most powerful political tool at the moment
While softer supply/demand balances point to weaker oil prices in H1 2012, global geopolitical risk outweighs the bearish fundamental signal. OPEC’s new 30m b/d production target will do little to cut down on oversupply in the market as we expect the call on OPEC will be below this target at 29.35m b/d for H1. Nevertheless, the recent sabre rattling between the West and Iran has pushed up the political risk premium by USD 6-8/barrel since mid-December. We expect oil prices to average USD 107/barrel in Q1 2012, but the risk is on the upside as the political risk premium may push prices higher.
Increased tension between Iran and the West
With President Obama signing a sanction bill on the last day of 2011, making it more difficult to sell Iranian oil, and most EU countries now supporting an embargo on Iranian oil, the pressure on Iran has clearly been building lately. In response to the recent pressure by the West, Iran has threatened to close the Strait of Hormuz, which would have an immense effect on the global oil market. The elevated rhetoric together with Iranian threats and naval activity in the Persian Gulf have increased the risk of confrontation.
We expect the political climate between the West and Iran to deteriorate in the weeks to come as the verbal war will continue and pressure will be building up to the next milestone – the EU meeting on 30 January. With the Arab Spring and production stoppages in Libya fresh in mind, the risk premium and oil prices may continue to rise before the EU meeting as the oil market is increasingly worried that the political tensions between the West and Iran will escalate to a military conflict that may harm oil production and transportation in the area.
The pressure is high on both sides
Neither Iran nor the US wants a military conflict in the region or to push the ongoing conflict too far. But the pressure is high on both sides. It is election year in the US and Obama has been criticised for being too soft on Iran. Tehran’s main goal is to scare the US and its allies away from implementing new and tougher sanctions which can break the country financially.
We do not expect that Iran will push forward a closure of the Strait of Hormuz or a military conflict as this would block the country’s ability to export oil and hurt the economy badly. Oil exports provide half of the Iranian government revenues and account for around 80 % of the total exports (EIA).
An Iranian closure of the Strait of Hormuz for an indefinite period of time will also have severe repercussions on the country’s most important trading partners, China and Russia. Thus it is not likely that Iran wants to use this tactic as it will isolate the country further both militarily and economically. China is the largest importer of Iranian oil with 543k b/d followed by Japan (341k b/d), India (328k b/d) and South Korea (244k b/d) (EIA). The increasing political tension in the area and the US sanctions have clearly started to hurt Iran’s trade relations as reported by the Financial Times today. Japan and South Korea are trying to reduce their dependence on Iranian oil by seeking new suppliers. China and India have not signalled that they will follow Japan’s and South Korea’s example and bow to the pressure from the US to stop trading with Iran. The countries can benefit from the situation as they are now in a position to push for lower prices of Iranian oil.
Higher oil prices increases the risk of a double-dip recession
Disruptions to the flow of oil through the Strait of Hormuz would threaten regional and global economic growth. Higher oil prices can push large economies over the edge and into a double-dip recession. A sharp fall in the world economy will have a severe impact on global demand for oil and may trigger a sharp fall in oil prices.
Saudi Arabia is the only oil exporter that is able to increase production substantially if global oil supplies are disrupted. OPEC’s total effective spare capacity buffer is 3.95m b/d today and Saudi Arabia accounts for almost 60% of this buffer. Saudi Arabia’s buffer alone is not enough to cover the potential loss of Iranian exports totalling 2.5m b/d. The growing appetite for the Kingdom’s oil from the EU in case it goes ahead with an embargo, and from Asian countries to reduce their dependence on Iran, is clearly cutting sharply into Saudi Arabia’s spare capacity buffer. The country’s ability to work as the producer of last resort will be weakened, making the global oil market more exposed to supply-side disruptions also outside Iran. The political risk is also high in countries such as Iraq, Nigeria, Kazakhstan, Sudan, Syria and Yemen, and including Iran these eight countries cover around 12% of global oil production or 13.745m b/d.
What may happen if the West attacks Iran? The response from Iran is expected to be severe and may lead to severe disruptions of oil supplies coming from the region. A military confrontation will increase the risk of damage to oil installations and tankers in the area that can halt oil production and transportation for an extended period of time. The entire area will be affected by a military attack on Iran and according to a Saudi journalist talking to the newspaper Al Jazeera that “will make damages beyond calculations”. Iran’s own predictions of an oil price around USD 200/barrel may then become a reality.
In addition, frustration with the current leadership in Iran is increasing, not only from the Arab countries but also internally. Isolating the country further economically and politically by souring the relationship to vital trading partners such as China and Russia and its Arab neighbours may put the current leadership under further strain. The Iranian leadership is trying to prevent a political uprising similar to those seen in Libya, Egypt and Tunisia this spring.
Thina Saltvedt
Senior Analyst
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